Vodafone's Two Worlds

LONDON -- It's now the biggest dividend payer in the FTSE 100, and Vodafone (NAS: VOD) duly delivered on its promise of 7% dividend growth in its results for the year to March 31, 2012.

The numbers were pretty much what the company had telegraphed. Revenue was up 1.2% to 46.4 billion pounds, and EBITDA down 1.3% to 14.5 billion pounds. Free cash flow was a solid 6.1 billion pounds after 6.4 billion pounds of capital expenditures.

Earnings per share were down 11%, driven by the loss of income from associates that were sold during the year and by higher finance charges and mark-to-mark losses arising from a switch into fixed-rate debt. Vodafone clearly sees interest rates rising in the future.

A new divideGroup results were held back by operations in Southern Europe, throwing the eurozone crisis into sharp relief. While the world was once divided into East and West or North and South, a new divide has opened up.

Revenue from Vodafone's Africa, Middle East, and Asia-Pacific region was up 8%, with rises of 25% in Turkey, 20% in India, and 7% in the South African-based Viacom. Its U.S. associate, Verizon, also saw revenue up 7%.

The European region was down 1% in aggregate. But that was a game of two halves, with revenue increases of 3% in Germany and 1% in the U.K. pulled back by declines of 5% in Italy and a massive 24% in Spain. An impairment charge of 4 billion pounds was taken on the smaller businesses in Greece, Portugal, and Ireland.

Only Australia bucked this trend with a 9% decline: A new CEO has been installed there.

Lasting solidityIt's a measure of the solidity and resilience of Vodafone that it can withstand the economic turmoil in the eurozone with its financial strategy intact. It is maintaining its target of 7% dividend growth next year and anticipating modest growth in its adjusted operating profit, with free cash flow holding stable. That's based on there being no "fundamental structural change to the eurozone." If the euro blows up, all bets -- and forecasts -- are off.

A sound strategyThe company has continued to execute the strategy of streamlining and focusing on three key areas of growth announced 18 months ago: data services, the enterprise segment, and emerging markets. All of the major noncontrolling interests (other than Verizon) have now been disposed of, with proceeds returned to shareholders through 6.8 billion pounds of share buybacks.

Investment in data services is paying off. Data revenue grew 22% last year as more and more users upgrade to smartphones. The enterprise segment now represents a quarter of Vodafone's revenue and should be boosted by its acquisition of Cable and Wireless Worldwide. The company jointly markets its enterprise solution with Verizon, making that relationship one of strategic and financial importance.

Emerging markets are expected to represent an increasing proportion of revenue, profit, and cash flow in the future. With the lack of fixed-line infrastructure in these markets, technology is likely to leap to mobile, offering immense opportunities for data growth.

This long-distance relationship is thrivingVodafone's 45% share in U.S. mobile operator Verizon produced 5 billion pounds of Vodafone's 11.5 billion pound operating profit. That business is performing strongly, with revenues up 7% and EBITDA up 8%.

That such a large slug of Vodafone's profits derives from an associate distorts the company's accounts. The income appears as a one-line entry and is excluded from the EBITDA figure. It reflects that Vodafone has little, if any, control over what happens at Verizon.

But, in truth, Vodafone is partially a play on U.S. mobile telecoms and is not so dependent on Europe, as the region's 72% contribution to EBITDA suggests. With Verizon's net debt reduced from $10 billion to $6 billion, there is potential for further dividends from the U.S. company to surprise on the upside. Vodafone shareholders received a special dividend in February after Verizon paid its first dividend to Vodafone.

Miles of upsideAlso with potential to surprise on the upside is the company's acquisition of Cable and Wireless, which is expected to enhance earnings in the first year (excluding integration costs). Vodafone will save third-party costs by using CW's fixed-line infrastructure. It may slash the 1 billion pound cost by selling off CW's undersea cable network, and CW's tax losses have not been priced into the deal.

Downside surprises could include Vodafone's long-running 1.5 billion pound Indian tax dispute -- where the government has now changed the game through retrospective legislation -- the turmoil of a euro breakup, and a falling-out with Verizon.

But perhaps the most attractive feature of Vodafone is that surprises are unlikely. On a prospective yield of 6% (at 170 pence), it's an appealing proposition.